00:00hi everyone welcome to the 1/6 + Z
00:02podcast today's episode features a Q&A
00:05with Charles Koch chairman and CEO of
00:07Koch Industries one of the largest
00:09private companies in the US with over a
00:12hundred billion dollars revenue as
00:13estimated by Forbes Koch also invest
00:16philanthropically in mostly education
00:17and communities as well as in politics
00:19and policy which we touch on briefly in
00:22this episode the interview conducted by
00:24Marc Andreessen covers everything from
00:26measuring talent and risk to the
00:28business of conglomerates change and
00:30innovation the conversation took place
00:32in November 2017 at our annual summit
00:35event other talks in the series can be
00:37found on our website at Asus and.com
00:39slash summit UNT MIT the 1950s received
00:43three degrees general engineering
00:44nuclear engineering and chemical
00:46engineering why did you decide to study
00:48those fields I didn't think I was good
00:50at anything and I found an early age I
00:52was good at one narrow field and that
00:55was math and logic and so I wanted to go
00:58to a school that had math as the
01:01language and I decided okay that I
01:04needed to learn a technical skill and
01:07that gave me a better chance of being
01:08successful as an entrepreneur than just
01:10studying business I got MIT and I
01:14quickly found out that yeah I was good
01:17at math and concepts but I wasn't very
01:21good at applying them to like operate
01:24devices or create devices so I maximize
01:28courses that were in science and math or
01:32theory and I became fascinated with the
01:35history of science the philosophy of
01:37science the scientific method and the
01:40principles of scientific improvement
01:43that was really the foundation for
01:46everything I've done
01:47and I learned innovations come from
01:51mixing existing ideas in new ways and
01:55later learned something from pliny
01:57called the republic of science which was
02:01that there is a scientific community
02:04that you all learn from each other but
02:07there can't be anybody in charge that
02:09dictates to the other or destroys the
02:12ability to make in of
02:14so it's what he called is an authority
02:17of the community not of any individual
02:20and as he put it that you exercise this
02:24Authority in general to bring about not
02:27its destruction but its modification in
02:31the particular and you use that to keep
02:34challenging the old theories and it's
02:37what Einstein said the best fate for any
02:40theory that any Theory can hope for is
02:43that it remains as a limiting case for
02:47the new theory so a lot of people when
02:50they talk about these ideas and they
02:51learn these ideas in school and
02:53especially at a place like MIT they
02:54think about them with respect to yes for
02:56sure this works this is the cornerstone
02:58of the scientific method for developing
03:00advancing science this also works for
03:02the development of Technology every
03:04every engineer knows that you need to
03:05have free and open criticism and debate
03:07around what's gonna work out logically
03:09like the rocket see they're gonna flyer
03:10it's not and you need to be able to have
03:12open debate without your doing it can be
03:15improved right right so that needs to be
03:17your state of mind but a lot of people
03:18don't then sort of take that under
03:20things like improving businesses as I
03:22got into business I said well this is
03:25great and this is critically important
03:27but I also need to understand the
03:30principles of social progress so I
03:32started reading everything I could in
03:34the social sciences whether that's
03:36philosophy sociology economics
03:39psychology and so on and what was really
03:43fascinated with me is the principles of
03:46social progress were almost identical to
03:50the principles of scientific progress so
03:54that really got me going on I got to
03:57apply this stuff because when you see
03:59all these different disciplines that
04:01come to the same point there's got to be
04:03some truth in it and when you see them
04:05applied in history and they determine
04:08whether or society was prosperous or
04:10miserable it gives you a few clues or it
04:14did me anyway after you're earning your
04:16degrees you ultimately moved back to
04:18Wichita and what to work for your
04:19father's energy firm I believe in 1961
04:21and then took the firm over in 1967 why
04:24did you decide to do that well actually
04:27finished at MIT I went to work for
04:28Arthur D little which then was a leading
04:31consulting company and I was as I say
04:34looking for the opportunity to go in
04:36business for myself so I pushed myself
04:39around to different groups I worked in
04:41product development process development
04:43then Management Services got to
04:45consultant strategy at age 25 well cuz
04:48when you're 25 you have a lot to teach I
04:55learned a lot and then I got to work in
04:58a group that consulted on innovation to
05:00help companies with their innovation
05:02process and commercializing their their
05:05innovations and after I've been there a
05:08little over two years doing this my
05:10father called me and he wanted me to
05:12come back and join his firm and I turned
05:14him down because I wanted to be in
05:17business for myself and about a month or
05:20so later he called me again he says son
05:22as you know my health is poor his blood
05:25pressure tended to run to 30 over 120 so
05:29he said I can't really run the company
05:32anymore and I don't have long to live
05:34and even you come back to run the
05:35company or I'm gonna have to sell it our
05:39main business was a crude oil gathering
05:41system and southern Oklahoma and then we
05:44had a company that made internals for
05:48distillation columns and then we had a
05:50130 interest in a in a small refining
05:53company in Minnesota named great
05:55northern oil company and so I'm saying
05:59well I've been looking for an
06:00opportunity to apply all these ideas
06:02what was it like to take over the
06:04do you know that you wanted to preserve
06:05and what in the company did you know you
06:07wanted to change well I wanted to change
06:08everything because it was stagnant and
06:11he was mainly focused on saving enough
06:14liquidity enough cash to pay for his
06:17death taxes so I started changing things
06:20and believe me applying these principles
06:23from society in science in how to run an
06:26organization it isn't as obvious as you
06:29might think I had a lot of trial and
06:32error mainly errors my benefactor the
06:34first thing my father said to me when I
06:36arrived he said son I hope your first
06:40otherwise you'll think you're a lot
06:41smarter than you are I didn't disappoint
06:44it you were able to accomplish that
06:46objective yeah yeah one thing I lived up
06:49to my commit is that right right foot to
06:50foot - just put one straight in the
06:51ground yeah and then after the races
06:53after that so walk us through how he
06:55thought about the evolution of the
06:56company over the last 40 years like was
06:58the goal to get gigantic or did you
07:00think about it in some other way well no
07:03the goal was matter of fact I plotted
07:05out after I got there here's how much we
07:09can grow some things worked others
07:12didn't but overall it caused us to grow
07:15I had developed this philosophy
07:19perpetual or continual transformation
07:22and that has basically two elements and
07:25one is to become counterparty of choice
07:28and not only with our customers but with
07:32all our other constituents employees
07:36partners our communities our regulators
07:40and society as a whole so how do we do
07:44that by focusing first of all now how
07:47much money we were make but how do we
07:49use our capabilities to create value for
07:52these constituents and then the second
07:55part is to believe however well we're
07:58doing as a company or however well we're
08:00performing as individual employees to
08:03realize it's not good enough that if we
08:07don't improve and improve faster than
08:09our competitors both existing and
08:12potential competitors we're not going to
08:14stay in business so each one of us has
08:18to be lifelong learners that is
08:20constantly searching for new and better
08:24ways to create value and so using that
08:28philosophy then in 1969 we were able to
08:31buy the rest of this refining company we
08:34start with okay what capabilities do we
08:37have and then what are the best
08:39opportunities where these will create
08:42the most value and then to constantly
08:45improve and add to these capabilities
08:48which then opened a new opportunity
08:51and then that calls for us to build
08:54additional capabilities that opens a new
08:56opportunity so the way I look at it's an
08:59endless cycle of creative destruction
09:02after we had acquired the rest of the
09:05great northern oil company we had three
09:08sets of capabilities we had crude all
09:11gathering which was starting to grow
09:13we had process equipment in the mass
09:16transfer or distillation equipment and
09:19we had a chemical processing in which is
09:24refining it's a form of chemical
09:26processing so here's what we did
09:28applying this philosophy then we grew
09:32crude or gathering business to become
09:35the largest in the u.s. in Canada then
09:38we did the same thing in gas liquids and
09:40natural gas and then we got into natural
09:43gas distribution we became the largest
09:46in asphalt distribution and got into
09:50ammonia distribution which then took us
09:52into the fertilizer business then we did
09:56the same thing in process equipment and
09:59built that a thousandfold we now call it
10:02our chemical Technology Group then we
10:05built that many times its size and then
10:08these capabilities then got us into
10:10chemicals polymers fibers and related
10:14consumer products and we got into wood
10:16pulping other forest products glass
10:20steel and now electronics and software
10:24let's pull out the key thread in there
10:26which is so right once upon a time the
10:28conglomerate model right was very
10:29popular and the idea was that companies
10:32should be in many different businesses
10:33because the different business you know
10:34the cycles of different businesses
10:35cancel each other out and so if your
10:37real estate brokerage isn't doing very
10:38well then maybe you're you know maybe
10:40your TV network will make up for it or
10:42vice versa and then that what you know
10:44that turned out not to work well because
10:45those unrelated businesses are actually
10:46hard to manage under one umbrella that
10:48then swung toward you know most of the
10:50business world towards very deliberate
10:52focus and in the sense of like we are in
10:53a business and then we need to get you
10:56know bigger and better in that business
10:57but we will not be a lot of permitted by
10:59our shareholders investors whatever not
11:01unrelated businesses it sounds like this
11:04which is not so much based on what
11:05business are we already in it's more
11:07based on what capabilities do we have
11:08it's centered around our management
11:10philosophy which we call market based
11:12management and we believe we have six
11:16core capabilities and that's commercial
11:19excellence operation excellence talent
11:23innovation trading mentality and public
11:27sector and all the businesses then
11:30shares what they're doing with the
11:33others you identified two core
11:34principles of counterparty of choice
11:36which is to say it's right to be the
11:37best partner in essence to all the
11:39constituents of a business in any other
11:41continual transformation get
11:42continuously better what you do though
11:44sound like an apple pie those sound
11:46obvious those sound like every company
11:48must do that every company must seek to
11:50be the partner of choice to all of its
11:51constituents every company must seek to
11:53continually improve but how can I mean
11:55if you're focused on your quarterly
11:56earnings and more worried about that
11:59than creating value for others and how
12:02many companies are really dedicated to
12:04creating value for your employees I mean
12:06I speak at business schools at night one
12:09of the students there say well isn't
12:11that kind of naive I mean you've got to
12:14be focused on your profits I said well
12:16don't you think it's naive the people
12:18are gonna want to do business for with
12:20you or want to work with you unless
12:21you're creating value for them now it's
12:23got to be a system of mutual benefit
12:25you've got to be compensated for that
12:27and to want to create value for an
12:30employee they got to be creating value
12:32for you and that's the atmosphere you
12:35want and believe me this works we've
12:37we've developed an investment of
12:39structures and that's why we're
12:41preferred counterparty because we don't
12:43go okay this is the way it has to be or
12:45not know we say what do you value what
12:48do you want for this and then we'll
12:50structure it any way you want but the
12:52more risk you wanted us to take then the
12:54more compensation we need and so we work
12:58it out to mutual benefit a lotta CEOs
13:00have written books they talk about the
13:01values of the company they talk about
13:03the principles there up on the wall
13:04they've got little cards that go on the
13:05wall and then you're actually in here
13:07she go inside the company or like well
13:08no that's not what they believe at all
13:10if you ask employees after a couple of
13:12years I'll tell you no that's not at all
13:13what it's like so how do you get to
13:15stake how do you go from the abstract
13:16principles through to implementation as
13:18for a company with over a hundred
13:19thousand employees like how does online
13:21hundred make sure this is major
13:24information disclosure going on right
13:26here over a hundred twenty thousand
13:27employees like if I'm a line manager at
13:29the company and I've never met you and I
13:31don't know you and how why did the
13:32principal stick with me well I mean we
13:34got different kind of principles we have
13:36the general president then we have what
13:38we call our guiding principles and as
13:41you say a lot of companies have this
13:43list of principles these principles are
13:45who we are as a company they guide
13:47everything we do who we hire we hire
13:50first on values and second on talent and
13:53when I say talent I'm not talking about
13:56credentials or what school we couldn't
13:59care less I mean it's like the NFL they
14:02don't first select a quarterback and has
14:05the best statistics they select the
14:07quarterback who has the best physical
14:09and mental capacity to lead the team to
14:13victory and so when we're talking about
14:16talent what potentiality do you have and
14:19we'll make sure you fully develop it the
14:21starting point is values when I talk to
14:24our people I say gosh if you're gonna
14:26hire somebody with bad values don't be
14:29hiring somebody smart har I'm stupid and
14:32slow because they will do less damage
14:34you look at the companies led by really
14:37smart people with bad bags and they're
14:40all broken so if I'm a line manager Koch
14:42Industries like what are my incentives
14:44like how does the incentive system
14:45support the values well there are lots
14:47of incentives and they're monetary
14:49incentives but they're also incentives
14:51is am i developing in any organization
14:55particular this is what the call of
14:57course an agency problem that the goals
14:59of the company and those of the
15:01individual are in conflict and there's
15:04always going to be a certain conflict
15:06because individual goals and motivations
15:09are different for a company so we try to
15:11do the best job of overcoming this
15:14agency problem most acquisitions we have
15:17is they have had an incentive program
15:19that is designed by consultants and it's
15:22point system or something
15:25and that doesn't work for us because
15:27what we want to do is have an incentive
15:30system that motivates an employee to
15:34maximize the long-term value you know
15:37the the Silicon Valley way of trying to
15:39apply and long-term value and defeat the
15:41agency issues is stock options equity
15:43ownership in the company because of how
15:45you're structured right the overwhelming
15:46majority of your employees by definition
15:49basically what you're trying to do is
15:50have people think like owners have your
15:52employees think like owners even though
15:53they're actually not owners who want to
15:55maximize the long term and how do you do
15:57that with cash compensation how do you
15:59get the cash comp system to work like
16:01equity would work we work awfully hard
16:02at this to understand what an individual
16:07employee has contributed to increasing
16:10the long-term value of the company and
16:12harmony with our principles okay what
16:15would you contribute to this year
16:16profits what did you do to help our
16:19culture to make sure we were living up
16:22to our guiding principles what you do to
16:25help our competitive position what
16:27innovations do you bring that might pay
16:30off in the future so it's a combination
16:32of objective measures and subjective
16:35measures and so every supervisors is
16:38expected to go that and we have the 360
16:41degree evaluations of everybody
16:43including me I get feedback on my
16:46improvement plan every year and it's a
16:49long list so I won't bore you with all
16:51that but the good thing is that you
16:54don't need to be precise but you need to
16:55be directionally correct if I'm an
16:57employee at your company can I make more
16:59money than my manager makes oh
17:02I mean and why shouldn't we does LeBron
17:04James make more than these coach what's
17:07the max is there a maximum on how much
17:08more I can make that my manager makes
17:09that has nothing to do with how much
17:11your manager although gets some of the
17:13credit for you performing well but
17:16there's no max we want everybody to make
17:19all they can based on the value they're
17:22creative so would you rather have an
17:24employee risk a project with a 50%
17:27chance of success 50% chance of failure
17:29and a 10 million dollar payoff or a 90
17:32percent chance of success and a 1
17:34million dollar payoff if you never have
17:36a failure you're not trying anything
17:38new and so we expect fierce but we don't
17:41want stupid failures if you have a
17:43correctly designed experiment so you
17:46gain knowledge from it and it's like
17:49Edison said after he'd had nine thousand
17:51failures trying to develop a new battery
17:54his friend says gosh Thomas I'm so sorry
17:57you've had all these failures he said I
17:59haven't had any failures I've learned
18:019,000 things that don't work this is
18:03poppers scientific method
18:05science has falsification when you come
18:08up with a theory you want to try to
18:10falsify it as quickly as you can if we
18:14got a bad deal or we're on the wrong
18:16track we want to know quickly so any of
18:19us like any idea I come up what we ought
18:22to do I get I say okay what are the key
18:24drivers of these who's going to be best
18:27at each one of those get together a
18:30meeting and I say okay now point out the
18:32flaws in this and challenge me and every
18:36time we go through that kind of
18:37discussion and debate come up with a
18:39better answer then I had myself I've
18:42never understood this people are so
18:44protecting their ideas defensive about
18:47it when somebody's pointing out the
18:49flaws need to thank them what if you'd
18:51based your career on that on a faulty
18:54proposition and they let you do it
18:57they're not your friends our worst enemy
18:59like you're driving a car toward a cliff
19:01at 100 miles an hour oh you're doing a
19:03great job keep it up I've never
19:05understood that yeah the interesting
19:07thing about what you just said is that
19:08it's very much in alignment with a lot
19:10of pus Silicon Valley operates both in
19:12terms of the venture capital model of
19:14funding startups where we're looking for
19:16similar high-risk high-return outcomes
19:18it's also what a lot of the big
19:19companies in the valley have figured out
19:20which is right you need to take these
19:21big backs you need to take that's a
19:23significant chance of loss to get the
19:24big wins failure is okay but like fail
19:26fat run experiment fail fast right and
19:28then learn and move on to the next area
19:30a critique that gets applied in the
19:32valley is that some companies will take
19:34it too far to failure is good and
19:38there's some dividing line between fail
19:40fast learn from your failures failures
19:42are an essential element of this whole
19:44thing - failure is good to the point
19:46just as an example there's a large tech
19:48company over my name with actually will
19:49they'll throw a big party when a project
19:51maybe the midwestern me where I've just
19:53like I can't quite reconcile myself with
19:54actually celebrating failure so how do
19:56you think about preserving this attitude
19:58of risk and experimentation but still
20:01having a culture of performance and
20:03accountability and things do have to
20:05work at a certain point we pay on the
20:06value created and so if we've had a
20:09failure but it was done very
20:11economically and we've learned quite a
20:14bit that could be a net positive because
20:17you had an experiment that showed that
20:19something we were going to do didn't
20:21work so that won't be held against you
20:24maybe a positive usually it's a net
20:27negative but if we learn something then
20:29that's on the positive side so let's say
20:33somebody had three or four failures with
20:36experiments and it was a war so that
20:39won't be deducted whereas if you had a
20:42dumb failure and you lose 10 million you
20:44made 20 million or you made 25 million
20:46over here you get credit for 15 so we
20:49net it out so if I'm an executive at
20:52your company like how many times can I
20:54fail before you start to ask the
20:56question that we used on me I'd be long
20:58gone all we care is are you contributing
21:02both in terms of our of our culture or
21:06our current and for the long term how
21:09many companies at scale in the world do
21:11you think have this kind of approach to
21:13management have this good for example
21:15this level of risk tolerance for new
21:16ideas and new ventures like how many are
21:18would be funny well we have a number of
21:20years ago one of the big banks we did a
21:21lot of business was asked me to come in
21:23and put on a 1-day seminar and so I said
21:26you know what's involved in applying
21:29this it's not a cookbook the leadership
21:33has to understand and live by the
21:35underlying principles I mean it's like
21:38with your kids if you preach one thing
21:40and you act in another they're going to
21:42do the opposite because they know it's a
21:44bunch of BS so the management has to
21:48understand these principles and see
21:50whether the procedures the mechanics are
21:54violating the underlying principles one
21:57of the interesting things about your
21:58company is you reinvest I believe 90
22:00percent of earnings 90 percent 90
22:02percent of earnings every year so
22:04I think most companies the scale would
22:06consider that to be impossible that
22:07there just can't possibly be that many
22:09productive opportunities to play capital
22:11have you found as it gotten must have
22:13gotten harder at scale why are you
22:15convinced that that's the right number
22:17as opposed to fifty percent or twenty
22:19percent well I saw our shareholders have
22:21agreed does that right and the reason is
22:25I think one is being private because we
22:28have a small number of shareholders
22:30outside of employees and they've seen
22:33that we can earn a higher return than
22:36they can personally investing and they
22:40have seen that we are large enough that
22:43paying 10% gives them all the money they
22:45need to do what they do so those are the
22:47key ingredients for our being able to do
22:50that so let's move on to policy and
22:52politics now so you in addition to
22:54becoming very well-known as a CEO you're
22:56better known as a policy activist I see
22:58yes the trajectory of this country is
23:01moving toward a system what I call a
23:04system of control dependency and
23:06cronyism that's undermining progress and
23:09pitting people against each other and
23:12what I'd like to move is toward as I've
23:14been talking about this system of mutual
23:16benefit where people succeed according
23:19to the value they create for others and
23:22so that involves policy but it also
23:25involves helping people go through this
23:28self transformation that's only where
23:30you're going to change society electing
23:32a better politician or something you're
23:36not going to solve the political problem
23:38with more politics we got to solve it at
23:41the grassroots level with individuals
23:44and helping them see opportunities and
23:46there are two sets of obstacles one's an
23:48internal obstacle that people don't
23:51believe they can learn contribute and
23:53succeed so they've got to overcome that
23:55and then you've got to help them find
23:58what they would be good at develop a
24:00valued skill and then use that to create
24:02value for others the amount of capital
24:04that you're deploying is large how do
24:05you think about the productive
24:06deployment of that much money into both
24:08politics but also the non political
24:10efforts perception is this is all about
24:12political action that you seem more
24:13interested in intellectual action the
24:15political part is more defensive so we
24:18speech open inquiry some decent
24:22immigration and free trade I am I am a
24:25total free trader this business on
24:27maximizing exports and minimizing
24:30imports is backwards I mean that's the
24:33old mercantilist deal right we're gonna
24:35export everything and pile up all this
24:38money meantime the people starve that's
24:40what Mao did to build up this military
24:42and what makes people better is not more
24:45money stashed somewhere
24:47but goods and services that make their
24:49lives better so I've never understand
24:51how they get that so backwards so the
24:54current discussion climate in the US and
24:56around the world is let's just say
24:57extremely negative at the moment and
24:59maybe has been for quite a while what
25:01are you the most optimistic about
25:02innovation where you need to get rid of
25:04this protectionism and have what we call
25:08permissionless innovation and that is
25:11have the burden of proof on the
25:13government that what you're doing is
25:15really unsafe so they can get a quarter
25:17or shut you down rather than have to go
25:21on everything and some things that takes
25:24like for a new drug it might take ten
25:26years and cost two billion so the drug
25:28prices are much higher than they did and
25:31this is not just true for for new drugs
25:34but it's from generic jobs you've got to
25:37get it improved as well and then finally
25:40your new your famously extensive and
25:41maybe even chronic reader give us two or
25:44three out of the ordinary books that
25:46aren't on the normal reading list that
25:47you would recommend the people real let
25:48me give you some essays I would read
25:51Michael pliny's essay republic of
25:54science I would read karl popper's essay
25:57sciences falsification I would read a
26:01couple of high ACT that competition as a
26:03discovery procedure and the use of
26:07knowledge in society I would read a
26:10chapter in Matt Bradley's book the
26:13evolution of everything called the
26:14evolution of technology I would read DJ
26:18McLouth skis op-ed in May
26:21a 2016 Wall Street Journal called how
26:24the West and the rest got rich and then
26:28I would read Charles Murray's book in
26:30pursuit of happiness and good government
26:33those are you want more that's that's an
26:35excellent homework assignment man thank
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